The Badulla Project - a scenario for investigating country risk in Sri Lanka

TABLE OF CONTENTS

Table of Contents........................................................................................................................................................... 1

Introduction .................................................................................................................................................................... 2

Discussion of risks and rewards ..................................................................................................................................... 6

Defining country risk .............................................................................................................................................. 6

Reasons for war .................................................................................................................................................... 8

Political Divisions................................................................................................................................................... 9

The Country Risk Matrix....................................................................................................................................... 10

Non-intrinsic modelling......................................................................................................................................... 11

Technical & Environmental factors................................................................................................................................ 13

Design and building ............................................................................................................................................. 15

Operate ............................................................................................................................................................... 16

Decommission ..................................................................................................................................................... 17

Economic Risks............................................................................................................................................................ 19

Implications for Badulla Project ............................................................................................................................ 21

Social & Demographic Risk .......................................................................................................................................... 23

Social .................................................................................................................................................................. 26

Poverty ................................................................................................................................................................ 26

Possible Solutions to Poverty............................................................................................................................... 26

International Risks........................................................................................................................................................ 28

OPEC.................................................................................................................................................................. 28

The World Trade Organization ............................................................................................................................. 29

Indo-Lank Free Trade Agreement ........................................................................................................................ 29

Kyoto Protocol ..................................................................................................................................................... 29

Impact of Kyoto.................................................................................................................................................... 30

Legal and structural issues........................................................................................................................................... 31

Land and property rights ...................................................................................................................................... 31

Intellectual Property Rights .................................................................................................................................. 32

Foreign Investment Protection.............................................................................................................................. 32

Dispute Resolution............................................................................................................................................... 32

Building the risk matrix ................................................................................................................................................. 34

Can we predict the future? ................................................................................................................................... 34

Badulla Matrix...................................................................................................................................................... 34

Conclusion ................................................................................................................................................................... 36

References .................................................................................................................................................................. 37

Web sites ............................................................................................................................................................ 38

Various resources................................................................................................................................................ 38

Table of Figures................................................................................................................................................... 39

Badulla Project – IBE Risk Assessment

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INTRODUCTION

This report forms an addendum to this group’s presentation on the Badulla Project, which

is used as a scenario for investigating Country Risk in Sri Lanka. In order to assess this

subject more realistically the; Political, Technological, Environmental, Economic, Social

Demographic, International and Legal risks have been assessed. In addition, the scenario

has been built drawing on our individual professional experiences and knowledge. This

project started its life as the result of a previous project undertaken by British Petroleum

(BP) on behalf of the Government of Sri Lanka a decade ago. This project involved a

seismic scan of the seabed off the southeast sector of the island (Figure 1). Further to this,

core samples were taken confirming a large quantity of quality crude oil; enough for

projected internal needs as well as satisfying forward export markets such as India and

China.

This project focuses on the next stage, which involved invitations to tender for a Build Own

Operate and Transfer Project. This tender was allocated to a joint venture partnership

consisting of:

• Sri Lanka Oil & Gas Corporation

• Daewoo Ship Building and Marine Engineering Company Ltd (DSME)

• BP Exploration

• India

Four Partners have formed a joint venture in a Build, Own, Operate and Transfer project

(BOOT).

Initially this project required the formation of a joint venture including design proposals for

the most suitable oil installation capable of recovering oil, gas, and condensate and for

the transporting of unrefined crude to a newly constructed refinery near to Hambantota.


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Figure 1: Location of project

In addition, the government has invested in several other infrastructure projects including

highway, port facility, and CHP (Combined Heat and Power) Electricity Generation at

Hambantota in support of a wider development plan.

Following a successful bid as a BOOT project, a licence to build and operate a facility was

won. This will eventually result in the transfer of all associated assets to the government at

the end of a 15-year period. However, provision at the design stage was also included for

“environmentally friendly” decommissioning of the spent assets.

Figure 1 shows the area where the basic seismic survey of the seabed was conducted

with sectors S5, E1 & D1 the most likely for drilling and location of the installation. Reserves

have been estimated to last forty years based on current known data.

Within a contracted 15-year period the joint venture will Design, Build, Own and operate

the facility based on recovering investment and operating costs plus $0.30 per $1.00 of

revenue raised. Therefore, $0.70 will proportionally belong to the state treasury. No tax will

be payable to the Sri Lankan Government during this period. At the end of this period a

further licence may be granted however no contract guarantee is fixed and is likely to be

a tax bearing period.


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A project team was formed and as a result, of the exploration data and seismic scan a

series of designs were proposed. Following research and tank testing based on wave

motion studies, environmental impact, local weather cycles and voyage planning models

the most suitable design was found to be a Floating Production Storage and Offloading

(FPSO) unit. This facility would offload product at sea via a connection hose to a Shuttle

Tanker that would operate between the Hambantota refinery reception facility and the

FPSO stationed in sector E1. Risk, Reliability and Safety Engineering studies also supported

this option.

Figure 2: Shipyard

As a selected joint venture partner Daewoo Ship Building and Marine Engineering

Company Limited (DSME) will employ their ship building facility on Geoje Island, near

Pusan in South Korea (see figure 2) to build the vessels. On arrival in sector E1, the FPSO will

be moored and connected a seabed pipe installation (known as a “Christmas Tree”) and

draw unrefined product from the field. Pressure will be regulated by onboard ancillary

equipment. The role of the shuttle tanker will be to take unrefined product from the FPSO

(see figure 3) and transport this to the refinery.


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Figure 3: FPSO and Tanker

For this project, we have determined that the country risk of Korea is not a significant

factor as it is rated low (Kennedy, 1997);

• External shock possible, not likely,

• Strategy fits context

• Policies are consistent,

• Economic management sound and economic performance meeting goals

• Political instability moderate.

• Further DSME’s reputation for delivering vessels on time, within budget andspecification is very good


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DISCUSSION OF RISKS AND REWARDS

The growing global economic environment we operate in today is fraught with risk which

we mitigate by examining the resultant rewards, a concept that’s been accepted since

biblical times when King Solomon first examined the risk/reward equation for trading with

Queen of Sheba. Today’s growth in the popularity (if not the absolute necessity) of

overseas investments, both in terms of portfolio and direct, has dramatically increased the

types of risks and the risk portfolios encountered by investors. A primary component of this

portfolio of risk would be country risk, by itself a portfolio of different components,

including country specific economic, political, social/demographic and, increasingly in a

world besotted with inter-border and exo-border conflict, terrorism risks.

Country risk has become important to investors because of the increasing number of

investments made in countries other than their country of domicile all over the world and

the resultant features of globalization that the world is today experiencing. Erb et. al,

writing for the Research Foundation of the Institute of Chartered Financial Analysts in 2001,

argued that the different risk/reward profiles of countries have been the primary drivers of

investment decisions by global investors in their pursuit of ROI’s (Return On Investments).

(Erb et. al, 2001).

Erb et. al posits that an understanding of the role of country risk will help investors

understand strategic portfolio decisions that drive global market exposures.

DEFINING COUNTRY RISK

A macro-economic definition of country risks finds that it is a concept linked to conditional

economic convergence of growth, asset prices, politics, trade openness, fiscal and

monetary policies, corruption or lack thereof, inflation, GDP per capita, wellness of the

population, average temperature of the capital, the time spent by the country’s political

leadership in their daily morning ablutions and host of other seemingly unrelated variables.

These, while seemingly unrelated, appear to converge at any given time to create order

out of chaos for the purposes of explaining the rationale behind an investment decision to

a board of directors.

However, on closer examination of all these components, it is apparent that political risk

outweighs all of the others that are market-based and measurable. Certainly, all of the

components have to be thought not only by itself but, specially, by the outcome of their

interaction. Frequently not easy to predict, political risk becomes more relevant due this


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inter-relatedness, with most of the government decisions directly effecting the economic

agents, its expectations, behaviour and the landscape where transactions are made.

On November 6, 2003, the Far Eastern Review reported how investors are driving Sri

Lanka’s stock market to be the second highest performing stock exchange in the world for

the year 2003. Quoting Arjuna Mahendra, the head of the country’s premier investment

authority, the BOI, FEER said how FDI investors are following the equity market investors.

Then, on 20 November, FEER had another report, describing how while life continues as

normal on the streets of Colombo, there is turmoil in the corridors of government.

Sri Lanka's president and prime minister FEER said are locked in a power struggle over who

should lead negotiations with Tamil rebels (who have been waging a secessionist war for

over two decades) and at what speed, placing the country's economic recovery at risk.

That crisis began on November 4 when President Chandrika Kumaratunga sacked the

ministers of defence, interior and information, suspended parliament and declared a state

of emergency, claiming she was unhappy with the government's approach to a peace

process, with the Tamil tigers which has been led by Prime Minister Ranil Wickramesinghe.

Sri Lanka has been reaping a peace dividend. Before November 4, the Colombo Stock

Exchange was at a nine-year high, and the country's GDP, which contracted 1.5% in 2001,

posted 5.6% growth by the middle of this year. Following Kumaratunga's actions, the stock

exchange lost 20% of its market capitalization in two days before recovering some

ground. It was only a few days before that Ranil Wickramesinghe was briefing President

George Bush in Washington on peace process, which has been the primary reason for the

turn around of the country’s fortunes.


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Figure 4: Up and away - performance before the crash

REASONS FOR WAR

The LTTE began fighting in 1983 for an independent Tamil state to be established in the

northeast of the country. They claim large-scale ethnic discrimination by the majority

sinhala community as the reason-de-etre for the move towards secession. Between then

and the signing of a ceasefire in February 2002, some 65,000 lives were lost. That ceasefire

followed Wickramesinghe’s victory in the December 2001 elections, for which he

campaigned on a peace ticket, much to the annoyance of President Chandrika

Kumaratunga, whose own attempts to achieve a peace deal had been consistently

undermined by Wickramesinghe and this party the UNP when they were in the opposition.

Kumaratunga belongs not to the UNP, but to the now opposition People’s Alliance (PA),

making her a president in opposition to the government in the strange bi-cameral system

of governance the country instituted in 1979. That, coupled with her disdain for

Wickramesinghe’s approach to the issue of the LTTE, made for a deal of antipathy

between the two throughout 2002. However, by the fourth quarter of last year, the


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ceasefire was continuing to hold and the LTTE had substituted its demand for full

independence with one of autonomy while remaining within the Sri Lankan state.

In addition, it dropped its previous insistence on an interim administration being

established in the north ahead of any final settlement. In response, Kumaratunga had

little option other than to soften her position; at least outwardly. Having beaten off an

attempt to remove her power to dissolve parliament, which the UNP had feared she might

do to scupper the peace process, she pledged not to exercise it.

POLITICAL DIVISIONS

However, underlying that somewhat ambiguous pledge of non-interference, huge

pressures remained. That pattern continued with her call in early 2003 to the government

to present what she regards as its ambiguous and highly concessionary peace plan to the

nation: “All the stakeholders in government and parliament, as much as all our peoples,

must be kept informed of the policy framework the government wishes to employ to

achieve peace.” In short, Kumaratunga’s remarks were a sideswipe at a process she

privately has little faith in.

The moves she made in November were simply a continuation of a de-stabilization

process Kumaratunga instituted to counter what she passionately believes to be a “sell-

out” of the country by Wickramesinghe.

In fairness to her position, her demand does have some substance. As things stand it

would appear that both the army and the LTTE will have to dismantle their respective

military capabilities in a brick by brick fashion if the entire process is not to be derailed.

However, a firm schedule for scaling down both sides would indeed be a useful tool for

achieving the peace and at some point would become inevitable. Wickramesinghe

obviously favours a measured approach.

That said, a derailment of the all important peace process has not yet become inevitable.

According to FEER, Kumaratunga wants to play a more central role in government and

the peace process. "Even though legally she's vested with enormous powers, the

government was able to marginalize her. She resented it.” FEER quoting a Jehan Perera,

head of the National Peace Council said.


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Figure 5: Comparative market performances

Since the take over of the Ministries, Kumaratunga has pledged that the ceasefire will be

upheld, as will the Norwegian facilitation, of which she has been sharply critical. She

knows that the Tigers, who have accused her of scuttling the search for peace, do not

want to negotiate with her.

The president has the option of dissolving parliament and asking the electorate to decide-

a course, which Wickramesinghe has told his ministers, he favours. However, a decisive

majority either way is unlikely. According FEER and other news reports, Experts say fresh

elections would return a parliament similar to the present one, where Wickramesinghe's

party holds a slender edge.

Overall, it appears that the status quo is holding, reflected again through the gradual

recovery of the stock market. Kumaratunga, while smarting from her inability to turn the

tide in her favour will find it difficult if not impossible to go against international, especially

donor interests and scuttle the peace process while Wickramesinghe will find it difficult to

push through changes that may have been not popular with the majority community. As

for how long this will remain in equilibrium is a difficult question to answer.

THE COUNTRY RISK MATRIX

Most rating systems use a number of data sources, with most systems ranking the data with

relative weights for political, economic, and financial risks according to perceived relative

importance. The perceptions are by themselves, proprietary to the assessors. In Appendix

1, two tables excerpted from Erb et. al. allows a comparison of the primary components of

CSE, plotted withDJIA, ASX, LSE


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10 different rating providers, clearly indicating how they emphasize different factors.

Some, such as industry leader BERI (Business Environment Risk Intelligence) emphasize

political factors, while, such as Bank of America, use more quantitative macroeconomic

information.

Clearly, the breadth and width of the different indicators tracked by the assessors itself is

an indication of the differences inherent in the assessment models employed.

NON-INTRINSIC MODELLING

Investment managers and planners are comfortable with concepts such as beta and

Sharpe Ratios (used in the CAPM model) when it comes to measuring portfolio risk.

However, can seemingly spontaneous events such as coups, election upsets and the

head of state’s mood swings ever be accurately forecast and factored into investment

decisions?

In July 1994, writing in Credit Lyonnais Securities Asia’s Research Digest, “Morning Line”

Kulatunga wrote that an expected change of government in Colombo, Sri Lanka will push

the equity market down 30% and have drastic impact on foreign direct investments.

(Kulatunga, 1994). This report followed an EIU country report, which indicated that there

will be no change in the market given that the contending parties appeared to be

sharing the same economic manifesto.

“We believe it is not policy, but the people who will implement that policy who (or what)

will matter in the short term. Given that the opposition PA largely consists of either people

who held administrative power seventeen years ago or a complete generation of those

who are being bloodied for the first-time in national politics, we do not expect a smooth

transition of power, and what is more important, we do not believe that once the

transition takes place, that it will be business as usual”. (Kulatunga, 1994)

The market not only dove down 36% subsequent to the change of government in

September 1994, but also never recovered to its levels held at the time of the publication

of the report of 980 in the All share index until the PA government fell from grace in August

2000.

Lilia Clemente, chairperson of Clemente Capital Inc., a stock-broking firm in Manila,

Philippines, has been writing to her investors for 20 years about risky investments.

According to the Institutional Investor magazine, in picking stocks for her two closed-end

funds, she routinely assesses factors such as economic growth, market and political risk,


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momentum and liquidity. She ranks such factors on a scale of one to five and uses her

analysis to construct investment scenarios and probabilities for each. (Institutional

Investor, July 2001)

Often her final decisions relied as much on hunch and experience as raw data.

Clemente’s father was a political prisoner during the reign of Ferdinand Marcos and

helped write the country's constitution after Marcos was deposed. That experience paid

off big for her investors. Clemente was on a fact-finding tour of Southeast Asia and was

strolling through the streets of Indonesia in early 2001, when she was struck by an alarming

thought--the angry crowds yelling their disgust for crony politics and widespread

government corruption were eerily similar to the crowds that gathered in the Philippines

shortly before Marcos fell. When she returned home, she cashed out her fund's position in

Indonesia, several months before political strife there toppled the Wahid regime and

caused economic chaos.

Kulatunga’s and Clemente’s experiences reveal one of the problems with the concept of

political risk: It is inherently hard to define, resists measurement, and often can be

discerned only as a matter of hunch. While measuring beta can at best be described as

a science, measuring political risk is most certainly an art.


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TECHNICAL & ENVIRONMENTAL FACTORS

With increasing importance being placed on managing stakeholder concerns regarding

exploiting the earth’s natural resources, an exercise will be undertaken to identify

associated environmental risks.

Figure 6: Colourful eco-system

This will also include margins on technology employed building, commissioning, delivery,

stationing, and decommissioning the assets offshore for the period concerned.

This venture will be Project Managed and within its scope provision will be made to identify

risks in a Risk Register in order to assess each risks likelihood and impact in order to see in

combination if the risks are low medium or high.

It is also recognised that the following will have an influence and are:

• Technical change on the local environment both positive & negative,

• Impact on Productivity i.e. increase in oil production effect on OPEC price etc

• Varying dynamism of each society

• Embodied and disembodied technical progress

• Impact of new technology on local region, investment in new infrastructure

• Need to change laws or consider laws such as training and employment of locallabour in operating and maintaining the vessels

• Provision of education, R&D etc

• Affected sectors- transport, communications, energy


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Figure 7: View from the seabed

It is recognised that this project will, like others, be entered into by the parties for an above

average return on investment. For those members with shareholders this will be aimed at

demonstrating its participation in increasing Economic Value Added (EVA) and return on

dividends to shareholders. In order, maximise the likelihood of this occurring it is

recognised that demonstrable good governance is of vital importance to current and

future investors. It is essential therefore that the benefits of employing the best possible

build quality and adherence to International and state laws are realised. Further given

the duration of the project it is expected that the design be fit for purpose in respect to all

technical and environmental aspects.


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DESIGN AND BUILDING

The vessel will be design in conjunction

with inputs such as operating

environment (considering the thirty year

wave) that will effect selection of

material, structural strength and fatigue

life.

Critical structural components of design

will use computer simulation techniques such a 3D finite element modelling as one of

many methods of risk control. Once the plans have been independently approved, the

vessels will be built under survey by Classification society’s surveyors. These surveyors will

on successful completion issue a package of legal certificates allowing the vessel to be

insured and traded. Insurance is only provided and maintained if the vessels remain

“seaworthy” as judged by the Classification Society. This acts as a further control on

technical risk.

These barriers and risk reducing factors are

deigned to lower identified risks as far as

possible to all stakeholders concerned

including the environment.

Figure 8:Computer 3D Finite ElementModelling of a ships section

Figure 9:FPSO & Shuttle Tanker onlocation


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The following controls will be used as further examples of reducing technical and

environmental risk;

Lloyd’s Register Rules and Regulations for the Classification of Ships covering;

• Hull Structure and welding

• Materials (Steel, composites etc)

• Paint (incl. lead free)

• Machinery and Piping Systems

• International Maritime Organisation (International Law) for;

• Pollution Prevention including;

• Oil Pollution

• Air Pollution Low NOx emissions and use of low SOx fuel

• Garbage

• Double safety hull- OPA 90

• SOLAS- Safety of Life at Sea

• International Standards Organisation (ISO) for controlled management:

• 9001:2000 Quality Management System (QMS)

• 14001 Environmental Management System (EMS)

Figure 10:Ship in the construction dock at DSME

•

OPERATE

In addition to the vessels being built to sound technical standards it is recognised that risk

is attributed to “Human Factors.” It is understood within the industry that over 85% of all

hazardous occurrences are due to direct human error. In the case of the Exxon Valdez

incident in Alaska, intoxication through alcohol consumption played its part, for example.


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As a minimum standard, the vessels will be manned by a full complement of sea staff

qualified in accordance with Sri Lankan Govt requirements under International Maritime

conventions covering:

Security:

As a requirement under International Maritime Organisation (IMO) the vessel andowners will be accredited against the International Ship & Port Security Code (ISPS),mandatory from July 2004. This requires a trained ship security officer and companysecurity officer to be appointed. In addition, the operator is required to haveestablished security plans and procedures that control and reduce the risk posed byterrorist and pirates.

Vessel Management:

Under the International Ship Management Code (equivalent to ISO 9001:2000onshore) a Designated Person Ashore DPA will be appointed from seniormanagement to act as appoint of contact in the event of an emergency under therequirements of the International Maritime Organisation (IMO). This code requiresmandatory regular drills to be carried out in order to allow all concerned to becomefamiliar with responding to incidents and hazardous incidents when they occur. Thisthen reduces the impact when events occur and also demonstrates a higher duty ofcare and requires;

Risk Register –

maintained for all likely risks onboard the vessel. It tracks loss time incidents andhazardous occurrences with a view to monitoring trends and identifying corrective andpreventative action.

Ship Emergency

Response Service (S.E.R.S) - As a measure of the level of commitment the Ownershave to good governance. The vessel will be registered with Lloyd’s RegistersS.E.R.S. This service covers the vessel in the unlikely event of the vessel runningaground or being involved in a collision were the integrity of the hull is compromised.Computer models of the vessel will be stored in a database which can be accessed24-7 and used to safely manage incidents.

DECOMMISSION

At the end of the project, the vessels will be assessed to see if a life extension programme

can be carried out. If because of a cost benefit analysis this cannot be pursued then a

decommissioning project will be started.

The softer issues highlighted by the case of Shell and Brent Spar serve to place things into

perspective with its disposal in the cold waters of the North Sea and its publication in the

hot waters of the media. This was despite a full and independently verified technical


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assessment which had produced a solution but which was not supported by everyone. It

is recognised therefore that decisions need to be driven by values and not solely based

on science. The aim will be to responsibly and safely render the shuttle Tanker and FPSO

into scrap taking due consideration of the environmental impact that pollution may cause

and reduce this to as low as possible. The vessels will not simply be sold and ran up the

beach to become a problem for another state. Due consideration will also be given to

the creation of a Delphi Panel including the involvement of respected environmentalist

bodies.


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ECONOMIC RISKS

Sri Lanka is currently in a state of economic recovery due to a serious downturn in 2001,

where the country recorded negative growth of 1.4% of GDP, as can be seen in Figure 9

(Budget speech 2003). This poor performance was largely due to external factors, with

the slowdown in global growth dampening demand for the country’s manufactured

exports, high oil prices increasing the costs of production and shipping, and a serious

drought lowering agricultural yields and hydropower generation (Sri Lanka Overview). The

situation was also compounded by the Liberation Tigers of Tamil Eelam (LTTE) attack on

the country’s international airport, causing tourism to plummet and war-risk insurance

surcharges on ships docking at Sri Lankan ports to skyrocket (Sri Lanka Overview). During

this time, inflation rode at 14.2%, industrial and agricultural production contracted as did

export earnings, the share market was stagnant and the budget deficit rose to 10.9%

along with fiscal and public debt, resulting in increased pressure on the exchange rate

(Choksy & Jayawardena, 2003). Political instability and mismanagement also contributed

to the ailing macro-economy.

Quarterly GDP Growth Rates

(6.0)

(4.0)

(2.0)

0.0

2.0

4.0

6.0

8.0

2000

-Q1

2000

-Q2

2000

-Q3

2000

-Q4

2001

-Q1

2001

-Q2

2001

-Q3

2001

-Q4

2002

-Q1

2002

-Q2

2002

-Q3

2002

-Q4

2003

-Q1

2003

-Q2

Per

cent

Figure 11: Quarterly GDP growth rates

Since this time Sri Lanka’s economy has been in recovery and enjoying steady growth of

more than 5%, despite a severe flood, that caused extension damage to the country’s

resources and infrastructure (Central Bank of Sri Lanka, 2003a). The government’s

structural reforms, macroeconomic, fiscal, and monetary policies have all aided the

recovery process. Furthermore, a $567 million grant from the International Monetary Fund


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to institute a 3-year economic program also puts Sri Lanka in a favourable position

(Choksy & Jayawardena, 2003). The impact can be seen in improved macro-economic

conditions such as greater fiscal discipline, declining interest rates, stable foreign

exchange market, and exchange rate and falling inflation, all have contributed to the

recovery (Central Bank of Sri Lanka, 2003a). In fact, inflation is expected to fall further to

7% by the end of the year, which will help stimulate growth and strengthen consumer and

business confidence (Choksy & Jayawardena, 2003). These positive projections can be

seen in the below figure.

Figure 12: Forecast summary


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Despite these short-term positive signs, Sri Lanka still needs to overcome their basic

economic problems such as poverty, malnutrition, and unemployment. The

unemployment rate is expected to reach 8.7% by the end of the year, due largely to the

lagging effects from the downturn experienced in 2001 (Central Bank of Sri Lanka, 2003b).

However, Sri Lanka has a well educated labour force with a literacy rate of 90%, and

English as a basic language and therefore there is potential (Mahoney, Trigg, Griffin &

Pustay, 2001).

All indications suggest that Sri Lanka is likely to experience higher growth from 2004

onwards and all the signs are positive. In addition, the increased economic integration

between Sri Lanka and India, through the Comprehensive Economic Partnership

Agreement will reduce trade and investment barriers, hence encouraging foreign direct

investment (Wickramesinghe, 2003). If fully implemented this will help increase growth and

investor confidence in Sri Lanka and throughout the region and perhaps lead towards

addressing some of Sri Lanka’s basic economic problems – unemployment and poverty.

However, this is dependant on the outcome of the recent political uncertainty, as

previously outlined. Direct investment is likely to spurn growth, however political instability

and the threat of conflict is likely to deter such pursuits, thus retarding the recovery. For

instance, the stock market had risen by 70% this year on optimism over the peace process,

however plummeted 20% after the president’s announcement, although they have since

bounced back (Pasricha, 2003). This reflects the effect that political instability has over the

economy and investor confidence.

IMPLICATIONS FOR BADULLA PROJECT

Overall, providing the political issues are resolved quickly, the impact on the economy is

likely to minimal and therefore Sri Lanka is likely to continue in its recovery phase and

experience increase growth. Couple with the stable exchange rate, declining inflation,

buoyant stock market and trade liberalisation, foreign direct investment is likely to be

favourable.

Furthermore, the government has recognised the importance of FDI for the country’s

growth and has made investment attractive by liberalising policies and increasing

incentives for such activity. Additionally, given the high unemployment rate, there will be

a sufficiently skilled workforce to service the project.

Therefore, providing the political instability and conflict does not continue and sound

economic policies and macro-economic management continues, the economic risk is


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likely to be moderate to high for the proposed project, although despite this risk, the return

potential of the investment is very high.


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SOCIAL & DEMOGRAPHIC RISK

The Democratic Socialist Republic of Sri Lanka (formerly known as Ceylon) Capital:

Colombo

Figure 13: Geography

Sri Lanka has an area of 65,610 square kilometres and with a density of population of 284.1

people/km with 19,408,635 people.

The people of Sri Lanka are divided into ethnic groups whose conflicts have dominated

public life since the nineteenth century.

The two main characteristics that mark a person's ethnic heritage are language and

religion, which intersect to create four major ethnic groups--the Sinhalese, the Tamils, the

Muslims, and the Burghers (GMID, Euro monitor, 2003)

Language: Its official language is Sinhalese. English is spoken among governments and

educated circles by about 10% of the population.

Religion: Theravada Buddhist, 69 percent; Hindu, 15 percent; Christian, 8 percent; Muslim,

8 percent.


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Statistics are going to be analysed showing issues related to the country risk of Sri Lanka:

Key issues 1997 2001 ! !

! Total

population

Total

population

Male Female

Immigration by nationality 169,657 179,125 ! !

Indian Citizens/Estate residents 52,640 40,728 ! !

Pakistanis 13,957 10,008 ! !

Commonwealth citizens 103,060 128,389 ! !

Population Growth rate ! 87% ! !

Birth rate 13.5/1000 16.58/1000 ! !

Death rate 6.5/1000 5.9/1000 68,604 42,496

HIV /AIDS ! 7500 ! !

Employment levels 6.0 million 6,942,811.00 4,745,810 2,197,001

Unemployment levels ! 700,395 323,846 376,549

Labour force participation (mining and

construction labour)

! 1686 1641 45

Literacy rates ! 90.20% 93.40% 87.20%

Figure 14: Key issues


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Immigration by Nationality to Sri Lanka

0

30,000

60,000

90,000

120,000

150,000

180,000

210,000

Immigration bynationality

IndianCitizens/Estate

residents

Pakistanis Commonwealthcitizens

1997

2001

Figure 15: Immigration

Because of the statistics showed in the above chart (figures 11-12), key issues can be

taken to be major factors influencing investment in Sri Lanka are;

The rapid growth that Sri Lanka has had during the last 30 years is due to immigration,

which has accounted for an estimated 40 to 70 percent of the population increase during

the 19th century.

Its attempt (unique in the South Asian context) to slow down population growth, reduce

poverty, empower women, and achieve economic progress has influenced its

demographic transition.

A drastic reduction with respect to demographic indicators such as crude birth rate,

crude death rate, fertility rate, maternal mortality rate, infant mortality rate, and child

death rate has been recorded within the past four decades.

Sri Lanka reached an advanced phase of demographic transition in a comparatively

short period and at a relatively low per capita income level.

To sustain the momentum that has been built up and to achieve the demographic goal of

replacement level fertility by the end of this decade, Sri Lanka will need continued

international support in specific areas such as contraceptive supplies, education, training,

monitoring, and supervision of the programme.


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SOCIAL

The major risk in which Sri Lanka needs to focus in order to manage its social problems is

poverty. This poverty is concentrated in urban areas, which are not receiving adequate

food to meet their energy requirements. Malnutrition is the second key issue related to

social factors. The major effect is Anaemia, which is especially prevalent in the young

population, affecting pregnant women and the unborn baby.

POVERTY

Poverty or food insecurity is a distinctly rural phenomenon in Sri Lanka with nearly 90

percent of the poor residing in rural areas. Between 25 and 39 percent of the population

can be classified as poor. Other factors include:

The poverty that Sri Lanka is facing, affects the health and welfare of their society causing

big problems to children’s education and growth.

Terrorism is also an important issue that is linked to Sri Lanka's poverty. This problem is a big

key issue for investors because it is affecting industries population etc.

Sri Lanka is influence by diverse ethnic groups, religions, and languages that differ by

region and level of social class. Among all ethnic and caste groups, the most important

social unit is the nuclear family--husband, wife, and unmarried children.

POSSIBLE SOLUTIONS TO POVERTY

There are many factors that can affect an investment in a country but not everything is

negative. Sri Lanka has created positive change over the last decades that provide for

increasing prospects for investment opportunities. This is further positively affected by

programmes such as those that aid the general community, encourage enterprise as well

as a general upgrading of infrastructure.

Sri Lanka has a three-pronged strategy for combating poverty;

• Achieving economic growth and development to create employment and improvethe standard of living,

• Achieving human development through the provision of improved health andeducation services, meeting basic needs, protecting vulnerable groups andensuring human rights,

• Direct interventions aimed at those who have not benefited from growth-relatedpolicies such as low- income groups.


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An example of positive State intervention is the Samurdhi Programme, which commenced

in June 1995 and was a major strategy aimed at combating poverty among marginalised

groups. Implementation was twofold: income supplement (programme), and social and

economy infrastructure development, with increasing employment opportunities covering

1.5 million families.

All these key issues are going to be vital for investment in this oil project because it will give

us an idea on how Sri Lanka's population can affect the project and at the same time,

know how the FDI will improve the society levels in Sri Lanka. International


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INTERNATIONAL RISKS

The following factors are considered strategically important in deciding to proceed with

the Badulla Project. Some of these international factors may impact immediately or may

become significant in the future such as:

OPEC

Given that OPEC Countries produce about 41% of the world's oil and 55% of the oil traded

internationally, any decisions to increase or reduce production may lower or raise the

price of oil. If demand grows, or some oil producers are producing less oil, OPEC can

increase its oil production in order to prevent a sudden rise in prices. OPEC might also

reduce its oil production in response to market conditions in order to counter falling prices.

OPEC members produce and therefore control about 41% of the world’s oil market and

can have an impact globally by voluntarily producing less oil. Sometimes they can agree

to produce more oil when there is a shortfall in supplies (such as during the Gulf Crisis in

1990, when several million barrels of oil per day were suddenly removed from the market).

Thus, the cartel benefits from and can take advantage of a raised price through a

shortage in supply.

At end-2001 world proven crude oil reserves stood at 1,074,850 million barrels, of which

845,421 million barrels, or 78.7%, belongs to OPEC Member Countries.

Other than OPEC product, other countries such as Saudi Arabia, Russia, US, Iran and China

also contributed about 28% of the world’s oil as tabulated as follow.

Saudi Arabia* 7.889

Russia 6.730

United States 5.801

Iran 3.572

China 3.297

Figure 16: Oil producers


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THE WORLD TRADE ORGANIZATION

As the member of the World Trade Organization (WTO), compliance with general rules of

trade between nations is essential. Under the WTO agreements, countries cannot

normally discriminate between their trading partners, such as granting someone a lower

oil price in order to get more market share over other WTO members. In the case of oil

market, the binding price tends to be the same as the OPEC price as their members

dominate the market price. In this situation, as Sri Lanka is one of the members of WTO

and also a small oil producer it might have cost disadvantage as compare to the other

large oil producers.

INDO-LANK FREE TRADE AGREEMENT

The signing of the Free Trade Agreement on 28 December 1998 between Sri Lanka and

India has resulted in greater protection of domestic and national interests in both

countries as well as to remove most tariffs on all goods exported from for Sri Lanka. The

Free Trade Agreement was fully implemented on 1 March 2000. During the 9 months after

implementation of Indo-Lanka FTA (April - December, 2000), Sri Lanka achieved an overall

33% growth in exports to India of which 71% (SLR.640 mn.) accounts for items exported

under the FTA. Under the Free Trade Agreement, Sri Lanka would gain immediate Tariff

concession for 4,916 (about 96%) items out of 5,112 tradable items. However, petroleum

oil and gases are categories under the Indian’s Zero Duty List under the Free Trade

Agreement.

KYOTO PROTOCOL

In 1997, more than 160 nations met in Kyoto, Japan, to negotiate binding limitations on

greenhouse gases (primarily CO2) for developed nations, pursuant to the objectives of the

Framework Convention on Climate Change of 1992. Each of the participating developed

countries was invited to decide how to meet its respective reduction goal during a five-

year period (2008-2012).

About 83 percent of the greenhouse gas emissions in 1990 were carbon dioxide released

by the use of energy, so any actions to reduce greenhouse gases are likely to have a

significant impact on energy markets and oil is one of them.


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IMPACT OF KYOTO

Based on the Sri Lanka Country Commercial Guide 2002, the Government’s fiscal deficit is

set to remain at about 10 percent of GDP. This was mainly due to high government

expenditure on defence, high imported oil prices, military equipment imports, and a

slowdown in the privatisation process. The war in the north intensified and the

Government spent almost one billion dollars on Defence.

The impact of OPEC, Kyoto, and WTO effects are likely to be important for Sri Lanka in

respect to the export of oil to countries overseas. However, due to the FTA with India – our

major buyer and the high cost of imported oil the prospect of local production and export

to near neighbour India is very favourable.


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LEGAL AND STRUCTURAL ISSUES

Foreign investment is welcomed in Sri Lanka. Law applicable to foreign investment is

Board of Investment (BOI) Law No.4 of 1978, amended 1980, 1983, and 1992. There are

two types of investment approvals granted to foreign investment under section 17 and

section 16 (www.boi.lk).

Under Section 17 of the Act, the BOI grants approval and special concession to foreign

investment to companies satisfying specific eligibility criteria, which are designed to meet

governmental strategic economic objectives. These approvals exempt and provide

waivers such as Customs duty, Exchange Control, Import Control, and remittance on

earnings and capital.

Approval under Section 16 of the BOI Act permits foreign investment entry to operate

under the 'normal laws' of the country. This means laws governing the Inland Revenue,

Customs and Exchange Control Laws shall also apply. Companies are treated equally,

regardless of whether the shareholding is controlled by nationals or non-nationals.

However, Board of investment and Bureau of Infrastructure Investment also provides

assistance for seeking approvals and the process takes only 7-14 working days.

Badulla project is expected to be granted approval under section 17 as it meets minimum

investment criteria and will be granted exemption on tax for imported equipment. In

addition, the project will also enjoy the benefit of 10 yrs of full tax holiday. Thereafter, 15%

tax preferential rate will be applicable (www.boi.lk).

LAND AND PROPERTY RIGHTS

Land and property rights are flexible for foreign investors who desire to purchase property

in Sri Lanka. Foreigners can purchase land by paying tax on 100% of the price of the land.

However, if a foreign investor incorporates a company under the Companies Act and

buys the land in the name of the company, tax payment is not required, even if the

shareholders of the company are foreign nationals. This is because a company

incorporated in Sri Lanka is deemed to be a citizen of Sri Lanka for taxation purposes

(www.boi.lk).


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INTELLECTUAL PROPERTY RIGHTS

Sri Lanka also provides protection to intellectual property through the Code of Intellectual

Property Act of 1979. The law provides protection to copyrights, industrial designs,

patents, trademarks, service marks, and trade names. Protection for trademarks is based

on registration in the Registry of Trade Marks. The registry follows the international grouping

set by the Nice Agreement of the World Intellectual Property Organisation with 34 classes

of goods and eight classes of services. Registration of a mark is valid for 10 years and

renewable for additional periods of 10 years (www.boi.lk).

FOREIGN INVESTMENT PROTECTION

Foreign investment is protected by the constitution under act 157 through recognition of

Investment Protection Agreements. All major political parties are committed to provide

free enterprise and individual freedom. No legislative, executive, or administrative action

can be taken to contravene it. Investment protection agreements and bilateral

investment protection agreements are valid for 10 years. They are extended

automatically unless terminated by either party. If the agreements are terminated,

investments already made are protected for another 10 years. Protection to investment is

provided against nationalisation, free remittance on earnings, and dispute resolution

under the International Convention for the Settlement of Investment Disputes (ICSID)

(www.boi.lk).

DISPUTE RESOLUTION

Disputes are settled by arbitration, which are recognized through the Arbitration Act. The

Act recognizes New York Convention on the Recognition and Enforcement of Foreign

Arbitral Awards. This means that arbitration awards made abroad are now enforceable in

Sri Lanka. Similarly, awards made in Sri Lanka can be enforced abroad.

Sri Lanka is also a founder member of the Multilateral Investment Guarantee Agency

(MIGA) of the World Bank, which provides guarantees against non-commercial risks, such

as those arising out of political changes or political instability and insecurity. MIGA issues

guarantees including co-insurance and re-insurance of investments, against non-

commercial risks such as losses resulting from expropriation, breach of contract, war, and

civil disturbances (www.boi.lk).

The legal environment for the project is friendly. Safety of investment is guaranteed

through the constitution; most importantly, no political party can contravene it. Moreover,


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tax-free import of equipment, 10-year tax holidays, and no restriction on remittance of

earnings makes it lucrative for investment. However, if practical implementation of such

policies is considered, there is not much of difference. Moreover, for a project of this

magnitude in which government of Sri Lanka is it self a party is less likely to face legal

implications.


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BUILDING THE RISK MATRIX

CAN WE PREDICT THE FUTURE?

Carleton University’s Country Indicators for Foreign Policy (CIFP) Project has attempted to

establish that in general terms, the factors that contribute country risk are categorized as

“structural factors,” “accelerators,” and “triggers. “ These, according to the project’s risk

assessment methodology report can be further explained as:

• “Structural factors” or “root causes” are those factors that form the pre-conditions of crisis situations, such as systematic political exclusion, shifts indemographic balance, entrenched economic inequities, economic decline andecological deterioration;

• “Accelerators” or “precipitators” are factors that work upon root causes in orderto increase their level of significance; and;

• “Triggers” are sudden events that act as catalysts igniting a crisis or conflict,such as the assassination of a leader, election fraud, or a political scandal.(CIFP 2002)

BADULLA MATRIX

After analyzing the systems that are publicly available for perusal (as against the high end

proprietary systems), The Badulla Team established a somewhat simple matrix ranking

system, based on a Delphi concept. The system essentially consists of six areas of root

causes, Politics, Technical, and Environment, Economics, Social and Demographics, Legal

and International issues. Within these six areas, further sub-division was done based on the

CFIP model, looking at accelerators and triggers that have causative affects on the root

factors.

The Badulla team delineated responsibility to according to individual strengths and

knowledge of team members, based on the Delphi principle. The members were then

required to come up with a briefing on the individual are of responsibility.

Following the briefing, all team members were required to evaluate the final root areas,

using a reverse cascaded weighting system. The final evaluation and the weighting is thus

based on the individual evaluations as well as a consensus approach, smoothing out

some of the outliers that were caused by individual biases.

Each of the factors were graded out of a maximum of 10 marks and averaged per

category. Further the group assigned a weighting factor and in this case for example it

was believed that Political and Economic factors had the most impact on Project Risk with

regards to Sri Lanka and were assigned a factor of 20 each. Technological and


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Environmental factors were categorised lower. This was due to the level of quality,

experience ad good record that DSME and BP have in the industry for building and

operating these types of assets together with demonstrable good governance.

Further, social, demographic factors were not seen as having a major impact on the

assets stationed offshore and the threat from terrorist groups were considered

manageable. This is further to the internal development programmes to alleviate poverty

and improve education. International factors were considered important but for this

project, the effect of any moves by OPEC would be minimal due to the nature of the

export market and a large portion of product being consumed by the internal market and

through FTA with India.

The Legal framework was also seen as being favourable for the project despite recent

political changes there seemed to be adequate provision for protection of Foreign Direct

Investment.


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CONCLUSION

! Aruna Nick Andrea Maria Inayat Annie Average Weight Composite

Political 8 7 8 9 8 8 8 20 160

Economical 7 6 7 7 6 7 6.67 20 133.33

Technical 3 3 3 2 3 2 2.67 8 21.33

Environmental 5 5 5 4 5 4 4.67 10 46.67

Sociological 5 6 4 5 2 4 4.33 5 21.67

Demographical 5 4 4 5 5 4 4.5 3 13.5

Legal 4 3 4 4 4 4 3.83 8 30.67

International 4 3 3 4 3 3 3.33 6 20

Total 38 80 447.17

Av 4.75

High Risk

10 to 7

Medium Risk

6 to 5

Low Risk

4 to 0

Figure 17: - Badulla Project Risk Table

It is therefore the conclusion of the group through the risk matrix that the risk level is

MODERATE at a figure of 447.17 out of a total possible 800 (considering weighting factor).

However to offset this we expect a high return on investment and so have agreed to

proceed with the project. Subsequently we intend to recommend to the board of

investors that the project be undertaken.


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REFERENCES

Belkaouli M, Belkaouli R, 1998, Nature, Estimation and Management of Political Risk, Greenwood

Publishing, London

Central Bank of Sri Lanka. (2003a). ‘GDP grew by 5.5% in the second quarter of 2003’. Press

Release, 30th September: www.lanka.net/centralbank/press_300903.doc.

Central Bank of Sri Lanka. (2003b). ‘Selected weekly economic indicators’. Economic Research

Department, 7th November: www.lanka.net.centralbank/wei_071103.pdf.

Choksy, K. N. & Jayawardena, A. S. (2003). Sri Lanka – Memorandum on economic and financial

policies for 2003 under the three year program of the PRGF-EFF arrangements.

Conflict Risk Assessment Report: Bulgaria, Romania, Slovakia, And Ukraine - 10 Country

Indicators For Foreign Policy (CIFP) Project, The Norman Paterson School Of International

Affairs, Carleton University, October 2002

Erb C.B; Harvey C.R; Viskanta T.E, 2001. Country Risk In Global Financial Management, The

Research Foundation Of The Institute Of Chartered Financial Analysts, Monogram 2001.

Far Eastern Economic Review, (November 06 and November 20

Gentile, Gary, 1998. Can Political Risk Be Quantified? Financial Planning, Sep 98, Vol. 28, Issue 9

IMO, 2003, International Convention for the Prevention of Pollution from Ships (MarPol 73/78),

IMO, London

IMO, 2003, International Convention for the Safety of Life at Sea (SOLAS), IMO, London.

IMO, 2003, Int'l Ship & Port Facility Security (ISPS) Code, IMO, London

Jarvis D, 2003, International Business Risk, Cambridge University Press, London

Kennedy C.R., 1991, Managing the International Business Environment: Cases in Political &

Country Risk, Prentice Hall, and USA.

Kennedy C.R., 1997, Political Risk Management: International Lending and Investing Under

Environmental Uncertainty, Quorum Books, and London.

Kulatunga A, 1994. Morning Line, Credit Lyonnais Securities Asia Daily Research Digest, 26 July

1994

Mahoney D, Trigg M, Griffin R, Pustay M, 2001, International Business: A Managerial

Perspective, Prentice Hall, Australia.

Oetzel, J. M., Bettis, R. A. and Zenner, M. 'Country risk measures: How risky are they?’ Journal of

World Business, Vol 36(2), 128-145.

Pasricha, A. (2003). ‘Political instability may hamper Sri Lanka’s economic growth’. New Delhi,

9th November www.voanews.com/article.cfm?objectID=EB15EEC9-8417-4F37-

B567ABF006BDDA1F.


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Solberg R.L., 1992, Country Risk Analysis – A Handbook, Routledge, New York

Wickremesinghe, R. (2003). ‘Making our people rich’. Businessline, 25th August:

http://gateway.proquest.com.alpha2.latrobe.edu.au:80/openurl?ctx_ver=z39.

882003&res_id=xri:pqd$rft_val_fmt=ori:kev:mtx:journal&genre=article&rft_id=xri:pqd:did=00

0000388518821&svc_dat=xri:pqil:fmt=text&req_dat=xri:pqil:pq_clntid=20828

WEB SITES

International Maritime Organisation: http://www.imo.org/index.htm

Sri Lanka Oil Pollution Prevention http://www.itopf.com/country_profiles/profiles/srilanka.pdf

Daewoo Ship Yard http://www.daewooshipbuilding.com/en/

British Petroleum: http://www.bp.com/

GMID: www.eurominotor.com.alpha2.latrobe.edu.au

Board of Investments: www.boi.lk

GOSL website: www.lk, www.gov.lk

Multi-lateral organizations: www.un.org, http://www.unsystem.org/, www.wto.org, www.opec.org

www.usatrade.gov/website/ccg.nsf/ShowCCG?OpenForm&Country=Sri+

Economics Intelligence Unit:

http://home.aigonline.com/content/0,1109,16302-844-ceo,00.html

Asian Development Bank

www.adb.org

IMF

http://www.imf.org/external/np/loi/2003/ika/01/index.htm.

http://www.imf.org/external/country/LKA/index.htm

http://www.imf.org/external/np/speeches/2003/101303.htm

http://www.imf.org/external/np/loi/2003/lka/01/index.htm

http://www.imf.org/external/np/sec/pn/2002/pn02100.htm

Sri Lanka Overview - www.adb.org

Reforms Transform Sri Lanka's Economy

http://www.oneworld.net/external/?url=http%3A%2F%2Fwww.panos.org.uk%2Fnewsfeatures%2F

featuredetails.asp%3Fid%3D1134%26null%3D0%26

VARIOUS RESOURCES

http://jolis.worldbankimflib.org


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TABLE OF FIGURES

Figure 1: Location of project ................................................................................................................3

Figure 2: Shipyard................................................................................................................................4

Figure 3: FPSO and Tanker.................................................................................................................5

Figure 4: Up and away - performance before the crash .....................................................................8

Figure 5: Comparative market performances....................................................................................10

Figure 6: Colourful eco-system..........................................................................................................13

Figure 7: View from the seabed.........................................................................................................14

Figure 10:Ship in the construction dock at DSME.............................................................................16

Figure 11: Quarterly GDP growth rates.............................................................................................19

Figure 12: Forecast summary............................................................................................................20

Figure 13: Geography........................................................................................................................23

Figure 14: Key issues ........................................................................................................................24

Figure 15: Immigration.......................................................................................................................25

Figure 16: Oil producers ....................................................................................................................28

Figure 17: - Badulla Project Risk Table.............................................................................................36

The Badulla Project - a scenario for investigating country risk in Sri Lanka

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